While discussing inheritance tax (IHT) at Mattioli Woods’ recent accountancy seminars, one topic stood out for me.
Much has been written on the residence nil rate band (RNRB), but you could still be forgiven for thinking the legislative changes in April 2017 gave your estate a £1m IHT-free threshold. Despite the introduction of the RNRB by the Chancellor being part of his efforts to make the IHT process “as smooth as possible”, once you have scratched the surface, there is – as I found out at these seminars – more to think about.
The current RNRB is £125,000, rising by £25,000 each year until it reaches £175,000 in 2020, which – when added to the £325,000 provided by the nil rate band (NRB) – equates to the £1,000,000 figure trumpeted upon its announcement.
Therefore, estates of individuals dying in this tax year could currently have a tax-free inheritance threshold of £450,000, rising to £475,000 on 6 April this year. The intention is the RNRB will be protected against inflation, increasing annually in line with the consumer price index (CPI) beyond 2020/21 tax year.
The RNRB is only available when a qualifying residential interest, which is a residential property the deceased has lived in at some point, is being passed to a direct descendent. Simple, right? Not quite. HMRC qualifies “direct descendants” as:
- a child, grandchild or other lineal descendant
- a husband, wife or civil partner of a lineal descendant (including their widow, widower or surviving civil partner)
However, for parents passing down wealth on their death, this also extends to:
- a child who is, or was at any time, their step-child
- adopted children
- a child who was fostered at any time by them
- a child where they are appointed as a guardian or special guardian when the child is under 18
Also, where the property in question is inherited by direct descendants in part only, the proportion of the property inherited will be reflected in the application of the RNRB. That is, the RNRB will be restricted to the value of the proportion inherited, not the total value of the house.
The RICS’ 2019 housing forecast suggests prices will “neither grow nor fall in the near future”, but Simon Rubinsohn, RICS chief economist said: “Looking a little further out, there is some comfort provided by the suggestion that transactions nationally should stabilise as some of the fog lifts.” Just in time for the application of the CPI-linked increase to the RNRB – which, if the price rises outstrip the rate of CPI increase – there will be increased liabilities for those on or above the nil rate threshold. This will only be enhanced for those with large property portfolios and compounded if you are on or above the £2m threshold, where tapering of the RNRB applies.
For example, if an estate valued at £2m grew by £10,000 in the same year, upon death that £10,000 would be subject to an effective IHT rate of 60%. This is because the applicable rate of 40% would be applied to the £10,000 and there would be a tapering of the RNRB at the prescribed rate, resulting in a reduction of £5,000 and a further £2,000 liability. Therefore, a total of £6,000 liability results for the £10,000 growth in the estate.
Whereas the recent stagnation of the housing market and the prescribed increases in the RNRB up to 2020/21 provide some solace, beyond this – as over recent years – increases to house prices have outstripped CPI and as main residences often represent large proportions of estates, the pending implications deserve more attention.
It is a common misconception some elements zero-rated for IHT purposes sit outside the estate for the £2m threshold for tapering. This is a consideration for those expecting considerable breaks due to business relief (BR), which is often used in certain IHT-efficient investment schemes and as a key tax break for business owners. The value of such assets would be included in the valuation of the estate upon death, which could have significant consequences on the RNRB.
The implications of the legislation are far-reaching and more complex than the “smooth” intentions of the Chancellor, which is one reason they are still widely misunderstood and why many commentators have suggested modifications may be made as a result of the current wider review of IHT going on at this time.
Despite the expected modifications, now is not a time to sit on your hands. As the Chinese Proverb goes: “The best time to plant a tree is 20 years ago. The second-best time is now.” Although the timeframe might not be appropriate, the sentiment is true of any financial planning – especially IHT and estate planning – given both the time-sensitive rules regarding gifting, and the annual nature of allowances.